The Australian dollar ... judged to be the world's most overvalued currency at the moment. Photo: HSBC

The Australian dollar is almost 12 per cent overvalued under REER, and overvalued by 12.2 per cent, according to The Economist's index.

Using the Organisation for Economic Co-operation and Development's measure of purchasing power parity, the Australian dollar is overvalued by 60 per cent.

'Currency war'

HSBC said in its report that currencies such as the Australian dollar, which are not actively participating in the so-called currency war, ''will likely see further upside should the conflict worsen''.

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''The currency war phenomenon means FX (foreign exchange) will lead other asset classes, rather than following them. FX is back in the driving seat.''

The bank's analysts added that the lack of active intervention in the foreign exchange market by Australia and New Zealand meant interest rates were less likely to rise in the next few years.

''Currencies are a relative game, and for those countries targeting a weaker currency, there is always going to be a flip-side stronger currency,'' they wrote.

''Australia and New Zealand continue to highlight the overvalued level of their currencies, a reality which has contributed to lower interest rates in the past and will likely hinder the extent of rate hikes in the years ahead.''

Stronger for longer

We’ll be out in the war zone with a peashooter.

ANZ currency strategist Andrew Salter said while the Australian dollar looked heavily overvalued relative to PPP, it was only slightly overvalued relative to the level of commodity prices.

‘‘If you take into account the income gain that has accrued to the Australian economy over the last few years as a result of the very high commodity prices, it’s a little bit more difficult to make the case that the Australian dollar is substantially overvalued,’’ Mr Salter said.

At the same time, the unconventional monetary policy measures some economies have taken to weaken their currencies, such as through quantitative easing - which in essence involves governments printing more money - have caused the Australian dollar to strengthen, and led to local interest rates to be slightly lower than they otherwise would have been, he said.

Mr Salter said ANZ expected the Australian dollar to remain around the $US1.05 mark for the rest of year.

While the bank forecasts interest rates to ease by 100 basis points to 2 per cent this year, reducing upward pressure on the exchange rate, the dollar would continue to remain popular among global investors given the high yields in Australia relative to the rest of the world.

‘‘That’s not just yields in equity and bond investments. It’s also on real estate as well. We’ve got some very high yields in commercial property in Australia relative to comparable investments overseas,’’ Mr Salter said.

Intervention a 'huge risk'

On Wednesday, New Zealand's finance minister, Bill English, said his country's currency was only a ''peashooter'' in the world's FX markets, and that he would not risk using its limited funds to intervene to lower the strong dollar.

''We have been pretty clear we are not willing to take the kind of huge risks involved in large scale speculation on the exchange rate with taxpayers' dollar,'' Mr English said after a parliamentary committee hearing, Reuters reported.

The New Zealand dollar has risen by about 11 per cent since May last year, Reuters added. Like Australia, the country's export sector has struggled to cope with the strength of its currency.

''We just don't want to take that kind of risks. We are a small country,'' Mr English added. ''We'll be out in the war zone with a peashooter.''

Reserve Bank of Australia governor Glenn Stevens briefly mentioned the Australian dollar in his statement following the central bank's decision to hold interest rates at 3 per cent for this month, writing that ''the exchange rate remains higher than might have been expected''.

HSBC's analysts said the ''currency war'', which has been carried by some countries through quantitative easing and the introduction of legislation, would intensify if the recent recovery of the global economy falters and countries jostle for the limited available growth opportunities.

The Australian dollar was this afternoon buying $US1.0356, 96.1 yen and 77.55 euro cents.